How do note buyers go about pricing notes?

[Michael L.]

Does anyone know how note buyers or the people that broker the note's go about determining how the will price a note? \Is there a formula for this?

[Jon Holdman]

Notes are the same thing as bonds. Lots more written about pricing bonds, so be sure you understand how bond prices and interest rates relate.

A note is a stream of payments. Given a known stream of payments (e.g., 28 years of payments at $500 a month) and a desired rate of return (e.g., 10%) its just a matter of plugging these three numbers into Excel or a financial calculator. The specific function is PV or present value. For this example, PV (10%, 28 years, $500 payment) is $56,308.82.

Now, a better question is how does the investor determine the rate they want? Every investor has some rate in their head that's their personal goal. If the note is from a strong borrower (credit scores 720+, solid job, good DTI, good cash reserves), then they will generally be willing to accept a lower rate than for a borrower with crummy credit. Similarly, a note with a low LTV will merit a lower rate than one with a high LTV. Seasoning will help, too. A freshly created note is going to require a higher rate than a note that has five years of good payment history.